Contractors typically maintain commercial general liability (“CGL”) insurance when working on a project. CGL insurance includes several types of coverage. Coverage A of the CGL protects an insured from injury or damages caused to a third-party, subject to several exclusions including what is referred to as the “your work” exclusion. The standard “your work” exclusion states:
This Provision excludes coverage for:
“Property damage” to “your work” arising out of it or any part of it and included in the “products-completed operations hazard.”
This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.
A CGL policy typically defines “your work” as the work performed by or on behalf of the insured and the materials, parts, or equipment furnished in connection with such work. The “your work” exclusion does not apply if the defective work was performed on the insured’s behalf by a subcontractor. “Product-completed operations hazard” includes damage occurring away from a premise the insured owns or rents arising out of the insured’s work or product (e.g., damages caused to the interior of a building from water seeping in from a roof improperly constructed by the insured).
District courts began interpreting the “your work” exclusion to exclude coverage for damages to the insured contractor’s work itself. Using the roof example, the cost to repair or replace the defective roof would be excluded (i.e., the work itself) but the cost to repair water damage to the interior of the building (e.g., sheetrock, light fixtures, flooring, insulation, studs . . .etc.) caused by the defective roof would likely be covered. District court decisions are not binding precedent. However, as a practical matter, the industry began operating under the governing principle that the cost to repair or replace the defective work itself is not covered.
The Minnesota Supreme Court finally interpreted the “your work” exclusion in the context of a construction defect case in King’s Cove Marina, LLC, v. Lambert Comm. Constr. LLC et al., __ N.W.2d __ (Minn. 2021). King’s Cove Marina (“King’s Cove”) sued Lambert Commercial Construction LLC (“Lambert”) over alleged defective construction. King’s Cove underwent a major renovation of the main building including, for example, new exterior walls, new windows, a new second level mezzanine for office space, and a new roof. Lambert performed work on the roof, siding, window installation, and wood floor installation. King’s Cove sued Lamberts for negligence and breach of contract alleging defects in Lambert’s installation of the roof and the roofing materials themselves, which allowed water intrusion into the in-floor heating system, which, in part, caused the concrete floors to move, crack, and expand.
Lambert tendered the defense of the lawsuit to its insurance carrier, United Fire & Casualty Co. (“United Fire”), under a CGL policy. United Fire denied coverage but provided a defense under a reservation of rights. United Fire admitted that some damages were covered claims but denied coverage for the repairs to Lambert’s work based on the “your work” exclusion. The district court held that some of King Cove’s property damage was caused by the actions of Lambert and thus coverage was afforded under the CGL policy. Not much further analysis was provided by the court. The Minnesota Court of Appeals reversed the district court’s holding and reiterated the common understanding that the “your work” exclusion bars coverage for property damage to (including cost to repair) the insured’s own work.
Lambert had opted to include products-completed operations hazard in Coverage A at an additional premium. Lambert argued that this inclusion means the “your work” exclusion did not apply. The Minnesota Supreme Court disagreed and held that the inclusion of products-completed operations hazard coverage did not create coverage for damage to Lambert’s work.
Moving forward, insurance carriers have binding precedent to rely upon to deny coverage for costs to repair or replace the insured’s work, even if the insured paid a premium for products-completed operations hazard coverage. However, if the plaintiff alleges damages to property adjacent to the insured’s work or otherwise outside the scope of the insured’s work, the insurance carrier still has a duty to defend the insured. The insurer will thus defend under a reservation of rights letter, which opens the door to a possible Miller-Shugart settlement. A Miller-Shugart is a settlement whereby the insured agrees to a specified judgment in favor of the plaintiff on the condition that the plaintiff will satisfy the judgment only out of proceeds from the insured’s insurance policy and that the plaintiff will not seek recovery against the insured personally; the plaintiff then pursues coverage from the insurance company.
Since United Fire had conditionally accepted the defense of Lambert per a reservation of rights, King’s Cove and Lambert entered into a Miller-Shugart settlement agreement. Per the Miller-Shugart, Lambert stipulated to a judgment of $2 million plus interest and costs and King’s Cove agreed to enforce the judgment against only United Fire. The scope of release included only the materials and work provided by Lambert, not the work provided by any other contractor. The parties estimated total repair costs to be between $4.5 million to $5.2 million and that Lampert’s proportional share of liability was 55.2%. Lampert was thus liable for $2.426 million to $2.87 million.
To be enforceable, the Miller-Shugart must be reasonable; a decision made by the trial court judge. United Fire sought to set aside the Miller-Shugart on the grounds that it failed to differentiate between covered and non-covered claims and was thus unreasonable. The trial court disagreed and approved the settlement. Judgment was entered against Lambert for $2 million, plus interest and costs, to be satisfied by any insurance coverage provided to Lambert by United Fire. The court of appeals reversed, holding that the Miller-Shugart was unreasonable and thus unenforceable because the parties failed to delineate between covered and non-covered damages. The Minnesota Supreme Court disagreed with this bright line rule and held that a Miller-Shugart settlement agreement that does not allocate between covered and non-covered claims is not per se unreasonable. Instead, the trial court judge is to apply a two-part analysis.
First, the court must find the overall settlement value reasonable in light of both the covered and non-covered claims. This is essentially the standard currently applied by trial court judges.
The Minnesota Supreme Court added a second step when a Miller-Shugart includes covered and non-covered claims: the court must allocate between covered and non-covered claims by considering how a reasonable person in the position of the insured would have valued and allocated at the time of settlement. In making the allocation, the court considers all relevant evidence on the issues of liability, damages, and risks of trials. Examples include (1) information that was available to the parties at the time of the settlement regarding the underlying facts, (2) materials produced in discovery and any court rulings in the underlying litigation, (3) evidence of how the parties and their attorneys evaluated the claims at the time of the settlement, and (4) expert testimony about the value of the settled claims. The plaintiff judgment creditor (i.e., King’s Cove) bears the burden of proof on allocation.
Most standard CGL policies contain a “your work” exclusion, which King’s Cove verified excludes coverage for damage to or repair of the insured’s defective work itself. Nearly all construction defect lawsuits involve damages to the insured’s defective work (non-covered) and damage to adjacent areas caused by the defective work (covered). King’s Cove rejected a bright line rule regarding the enforceability of Miller-Shugart settlements that fail to allocate between covered and non-covered claims. Instead, King’s Cove held that the allocation lies within the discretion of the trial court judge upon consideration of all relevant evidence. Given the uncertainty of the outcome, parties to a Miller-Shugart should attempt to agree on a fair apportionment.